China sticks to its stance as yuan marches higher

Central bank head maintains domestic factors are behind appreciation

By

LisaTwaronite

SAN FRANCISCO (MarketWatch) -- As China's yuan continued its steady upward march, the governor of the People's Bank of China continued to emphasize his government was allowing its currency to appreciate in response to internal conditions.

On the sidelines of the Bank for International Settlements meeting in Basel, Zhou Xiaochuan told reporters Monday that high inflation, high oil prices, China's trade surplus as well as domestic Chinese trading conditions were behind recent foreign exchange trends.

"We see that the trade surplus also to some extent has slowed down but the absolute level is still high," Zhou said, according to Dow Jones Newswires.

Supply and demand in China's onshore foreign-exchange market was another contributor to the yuan's recent strength, Zhou reportedly said, noting heavy selling of foreign currencies by some onshore financial institutions.

"All these factors may be major factors to affect formulation of the [yuan] exchange rate," Zhou said.

The latest remarks are solidly in line with Zhou's comments in recent months that the yuan exchange rate will gradually reach a "balanced" level and will help bring equilibrium to the country's balance of international payments.

China ended its currency's peg to the dollar in July 2005. Chinese financial officials have said the yuan will be allowed to gradually strengthen.

For years, Chinese officials have shrugged off calls from other nations -- as well as organizations including the Group of Seven and the International Monetary Fund -- to allow its tightly controlled yuan to appreciate at a faster pace.

The yuan's relative weakness against other currencies gives Chinese exports a competitive edge in overseas markets.

Tighter policy

Most analysts said China is not simply stalling to reap the benefits of a weaker currency, but rather that it is well aware of the risks of allowing its currency to appreciate before its domestic economy and financial systems are ready for it.

But the yuan has been on an accelerated upswing, suggesting China believes the time has come.

"We expect the theme of faster yuan gains and rising exchange flexibility to continue into 2008," Claudio Piron and Yen Ping Ho, currency strategists at JPMorgan, said in a recent note to clients.

"The domestic environment of excessive liquidity and rising inflation should continue to work in favor of this view, and recent administrative measures to contain inflation and increasingly aggressive monetary action are suggesting that policy intent to tighten remain high," the J.P. Morgan analysts said.

Late last month, the People's Bank of China raised its benchmark one-year lending by 18 basis points to 7.47% and the one-year deposit rate by 27 basis points to 4.14%, after the consumer-price inflation hit an 11-year high in November and producer prices reached the highest rate of increase in nearly three years.

Another record close

Earlier Monday, the yuan closed at another record high against the dollar in Chinese over-the-counter trading.

The yuan rose to 7.2690 against the dollar, compared with 7.2730 Friday.

In its tightly controlled currency markets, China permits the yuan to trade in a band of 0.5% on either side of its official parity rate, which it sets daily.

On Monday, China set the yuan parity rate at 7.2695 to the dollar.

Last week, Standard Chartered Bank predicted that the yuan would rise 9% in 2008 and then gain 7% in 2009.

The yuan gained 6.4% in 2007, "after a rapid and unexpectedly sustained appreciation in the final weeks," wrote Standard Chartered economist Stephen Green.

"The People's Bank seems more willing to throw the exchange rate about a bit more, perhaps wanting to signal to corporate China that more appreciation is on the way," he said.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.